The newly public New York Stock Exchange just unveiled a $10 billion offer for Paris-based Euronext, which owns securities exchanges in France, Holland, Belgium, Portugal, and England. Meanwhile, Nasdaq last week announced it had amassed a 25 percent stake in the London Stock Exchange.
On the surface, these transactions seem to represent American triumphalism—well-capitalized U.S. firms leading a process of globalization, the new financial world consolidating the old world.
But the truth is a little more complicated. Both these bids are defensive moves. NYSE and Nasdaq, the two exchanges that ruled global finance in the 1990s, are now desperate not to be left behind in the new world of global finance that they helped create. Sure, half the population owns stocks, and common stocks are the investment of choice for mutual funds, pensions, and hedge funds. But they're not nearly as hot as they used to be. And in the area that has emerged as the next big thing in securities—derivatives—the NYSE isn't a big player.
Derivatives are financial instruments that derive their value from the value of another security or object. Futures contracts on pork bellies, crude oil, sugar, or copper, options on Wal-Mart or the S&P 500, and a bewildering array of securities linked to the movement of currencies, interest rates, housing prices, or even events—like the likelihood of a company defaulting on its credit. All these are derivatives.
The volume and investor interest in derivatives have soared in recent years for a variety of reasons, in part because stocks of big companies have been boring and less volatile. It's difficult for professional traders to find much of an edge in the trading of Wal-Mart or General Electric when they simply move sideways over a several-year period. Meanwhile, commodities such as oil, natural gas, gold, platinum, copper, and ethanol have become highly volatile. The main way to play these markets is through derivatives. And the explosion of government and corporate debt in recent years has led to the development of new products that allow investors to assume or hedge interest-rate risk.
Money always floods into the hot new areas. And so the volume of derivatives traded on the Chicago Mercantile Exchange has more than doubled since 2001, and the value of the contracts traded has nearly doubled since 2002. As a result, CME, which went public in 2002, has seen its stock soar. It's worth about 50 percent more than the NYSE. The Chicago Board of Trade, where contracts and futures are traded on gold, silver, ethanol, and government bond futures, just turned in a great quarter. The upstart International Securities Exchange, which was founded in 2000 and specializes in trading options on stocks and stock indexes, went public last spring and reports a 30 percent market share.
The New York Stock Exchange has been late to the party. It went public late, with its March merger with Archipelago. It maintains a market-leading position in stock-trading, fueled in large part by program trading. But it is a small player in derivatives. As its first-quarter results show (see the April 19 release), NYSE's market share in equity options contracts was only about 11 percent.
The most appealing thing about Euronext for NYSE could be its large and growing derivatives business. Euronext shrewdly acquired the London-based London International Financial Futures and Options Exchange in 2002. And while it's commonplace for Americans to regard Europe as a financially constipated market, London has been a hotbed of derivatives innovation. As Euronext's first-quarter results show, derivatives provided about 38 percent of revenues and 43 percent of operating income.
If you think it all sounds very postmodern, you're right. Derivatives are referential securities, commentaries on underlying assets. They raise all sorts of questions as to what a symbol signifies and what values are embedded in the price of a security, which is, after all, a mere byte of digital information. It's the sort of thing a French structuralist could noodle endlessly over a few demitasses at a cafe in St. Germain. And as he puffs on a cigarette and waves ironically through the clouds of curling smoke, he might also notice another irony. The NYSE—for two centuries at the vanguard of American capitalism—is now finding itself having to buy a European exchange in order to get into the hottest new business in the securities industry.